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Payments and liquidity under adverse selection

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  • Rocheteau, Guillaume

Abstract

Informational asymmetries regarding the future value of assets affect their role in exchange. I construct a random-matching economy composed of two assets: a risk-free bond and a Lucas tree whose terminal value is privately known to its holder. No restrictions are imposed on payment arrangements. The main finding supports a pecking-order theory of payments: Agents use their risk-free bonds first in order to finance their spending shocks, and they use their information-sensitive assets only if their holdings of bonds are depleted. The theory has implications for the optimal provision of risk-free bonds, the structure of asset returns, and liquidity.

Suggested Citation

  • Rocheteau, Guillaume, 2011. "Payments and liquidity under adverse selection," Journal of Monetary Economics, Elsevier, vol. 58(3), pages 191-205.
  • Handle: RePEc:eee:moneco:v:58:y:2011:i:3:p:191-205
    DOI: 10.1016/j.jmoneco.2011.06.005
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